Dr Omar Davies arrives at Gordon House yesterday.
Whilst the Budget Debate is about the planned expenditure for fiscal year 2004/2005 and the way in which this would be funded, much of the issues which arose in reviewing fiscal year 2003/2004 had their genesis before.
As such in discussing the period it is useful to look at the challenges and set backs, as well as the successes/achievements for the 15 month period - January 03 to March 04.
The first six months of the calendar year i.e. Q4 of 02/03 and Q1 of 03/04 'difficult', to put it euphemistically. The first signs of wider than projected fiscal deficit had emerged and difficulties emerged both domestically and externally which made economic management challenging.
Period started with uncertainty related to a possible war in Iraq. In February of 03, we were forced to purchase FE from the NIR to pay down a Euro bond which had matured thus simultaneously diminishing the NIR and raising questions about the ability to maintain a stable exchange rate system.
These uncertainties fed on themselves, leading to intense instability in the FE market and devaluation where the exchange rate bottomed out at J$70 to (US)$1.
The Administration took action, involving intervention, a significant hike in interest rate and an offer of unlimited indexed bonds which restored order to the system. The rate has remained at about the same level (just of J$60:US$1) since that intervention.
This side of the House was intrigued by the fact that during a recent debate, Opposition Spokesman on Justice opined that, the intervention to stabilise and reverse the deterioration in the FE market was ill advised.
The size and range of goods and services affected by the tax package also contributed to the difficulties in the first half of the calendar year. Several changes/adjustments were made and the delays in finalising the set of measures itself contributed to the uncertainty.
In any event any tax package equivalent to 3.5 per cent of GDP must have severe impact on the population as disposable income would have been reduced.
The combination of devaluation and the tax package led to movements in the CPI not seen in over seven years.
Externally, downgrade of our bonds by the rating agencies increased the difficulty in accessing resources externally, thus forcing almost total reliance on domestic financing.
The inevitable results were of higher interest rates and the need to increase short-term issues. Managing in that scenario posed extreme challenges.
Successes/Positives: Despite all the above challenges, as significant as they were, simultaneously there were significant positives in the real economy. We will focus on three agriculture, bauxite alumina and tourism.
Agriculture: Rebounded six major natural shocks (floods and drought) between 1999 and 2003. Grew by 5.7 per cent in 2003.
Bauxite/Alumina: During calendar 2003, the bauxite alumina sector was operating at close to maximum capacity and demand on the world market for alumina pushed prices beyond original projection.
Tourism: The tourism sector had perhaps its greatest year ever with records being established in long-term visitors, cruise ship passengers as well as total visitor expenditure. The recovery of the industry had not only positive results in terms of the viability of properties but also contributed to greater stability in the foreign exchange market and improvement in the balance of payments. The growth in these sectors of the real economy, was a major contributor to the overall economic performance. Perhaps more importantly, these were not one-off occurrences. They were simply laying the basis for the growth in the medium-term about which I will have more to say.
With the improvements in the real economy we turned our attention in Q3 to restoring confidence in the country on the part of external creditors, particularly those in Europe. This was achieved initially through tele-conferences, but finally by a major tour through the financial capitals of Europe.
We discovered to our surprise that here was widespread confidence in Jamaica's economic future but creditors, both past and prospective, felt that we had tended to neglect Europe focusing too much on North America. It is an error we will not repeat.
The positive response in Europe was occurring in spite of the impact of the difficulties in Argentina on creditors in Europe. Useful to elaborate on this point.
The fact is that whilst in North America most of the bonds issued by a country such as Jamaica are purchased by institutions, in many European countries e.g. Italy and Germany, the purchasers are individuals, oft times, pensioners who buy and hold. As such when one utilises part of one's pension to purchase an Argentine bond and down the road when that bond matures, there is no payment forthcoming, this translates not simply into a lower profit margin for a financial institution, but into financial melt down of individuals and families.
There are two critical lessons here for Jamaica. The first is that despite the cost, the decision to intervene through FINSAC and protect savers, holders of insurance policies and pension funds was the correct one. The second lesson is that our history of never reneging on our debt obligations, regardless of the fiscal pressures has helped us to establish a niche in the external capital market.
People who buy our bonds know that when the time comes for us to repay we will. It differentiates us from many other countries and lays the basis for us to confound critics and the analysts with the successful Euro issue in February.
That successful Euro issue of ¢200 million (approximately (US)$250 million following the (US)$100 million loan obtained from BNS in December simultaneously reflected a change in market perception and confidence and impacted on both positively. Everything is indeed everything.
The additional resources have helped to accelerate the downward movement in interest rates domestically and have provided the Central Bank with resources to further stabilise the foreign exchange market.
Hence, for the first three months of 2004 (Q4 of 03/04) there has been a 'gelling' of positive outcomes which have re-inforced each other. There was the performance in tourism, mining and agriculture. There is stability in the FE market, there was a reduction in domestic interest rates and perhaps most critical, there has been very good fiscal performance.
THE FISCAL
The members of this House and the general public may wonder why the Administration has placed so much emphasis on the attaining of fiscal targets for 03/04 and indeed for the medium-term. The Prime Minister and I have, on several occasions, reiterated that the target of eliminating the fiscal deficit during fiscal year 05/06 remains and will be met.
To achieve this target, the critical element is to attain a primary surplus of the order of 12 per cent and above, over a three-year period. In my last meeting with the former Managing Director of the IMF, Mr Khler, now the German President, he questioned the feasibility of our attaining our fiscal targets as he felt it would not be possible for a country to achieve them and maintain social stability.
Many others felt like he did and many analysts confidently asserted that we had no option but to go the route of Argentina and re-structure our debt.
The only question, they argued, was whether we would seek to work with our creditors or do it unilaterally. I told Mr Khler and all other creditors Jamaica will honour its debt obligations.
Whilst attainment of the targeted primary surplus is indeed difficult, the plain fact is that short of some country either writing off significant debt or giving us significant grants, we have no option but to eliminate the fiscal deficit in our quest to bring down interest rates. There is no option.
There were times during the fiscal year when both the level of revenues collected, as well as the level of expenditure occasioned by the higher than projected interest payments, caused concern amongst our creditors about the fiscal targets.
In fact, in December 2003, my presentation to members of the Trade union leadership showed that unless there were tight management of the budget we could be headed for a deficit equivalent of 10 per cent of GDP in 2003/04 and a worsening situation thereafter. This was the document which got into the hands of the Leader of the Opposition and which he gave great publicity, locally and internationally.
. At that stage we felt it necessary to provide to the public a revised projection of the expected deficit. We announced that rather than the target of 5-6 per cent of GDP, we expected to end the fiscal year with a deficit of 6.9 per cent of GDP. Whilst this represented a missing of the original target, it was significantly different from Mr Seaga's 10 per cent of GDP.
That projection of 10 per cent of GDP sent shivers through the market and forced us to redouble our efforts. Everyone should be judged in terms of what is expected of him/her and what the final outtrun is. The budget as presented last year projected revenues of $147 billion, the outtrun was $151.4 billion. The budget of last year projected expenditure of $171.4 billion, the outrun was $179.6 billion. Simply translated we spent $8.2 billion more than projected.
However, domestic interest costs were $11 billion more than we had budgeted for. Put another way, had domestic interest rates not been raised because of the problems which I have outlined above, our expenditure levels would have been on target. Furthermore, we could have used the additional amount spent on interest to deal with the capital projects and clear outstanding obligations.
But back to the fiscal numbers. The fiscal deficit for fiscal year 2003/04 in dollar terms was $28.2 billion. This converts to a fiscal deficit as a percentage of GDP of 5.8 per cent. We have made the target of a deficit of 5-6 per cent of GDP.
There is a clear message for our creditors at home and abroad. Judge us in terms of our performance and we expect that the reward will be lower interest rates thus allowing us to dedicate more sums to address the social and economic needs of our people.
I now turn to an issue concerning the fiscal accounts which arose during the discussions at the Standing Finance Committee on the way in which expenditure for fiscal year 2003/2004 was financed. The Opposition Spokesman on Justice asked about 'advances' made by the Central Bank to Central Government, specifically during December 2003.
The specific answer to his question is that the Bank of Jamaica made no 'advances' to the Central Government in December 2003 or at any time during FY 03/04. In fact, the last time that the BOJ made any such advance to the Central Government was in 1992.
The question posed is so important that it is imperative that we place firmly on the record of the House the facts about the financial relationship between the Bank of Jamaica and the Central Government. I have indicated that the last time advances were made by the BOJ to the Central Government was in 1992.
Up until 1992 the BOJ acted as banker to the Central Government with Central Government's revenue and expenditure accounts maintained in the Bank of Jamaica.
As the Government's banker, the BOJ provided advances to the Central Government when resources were inadequate to cover expenditure.
Ministries and departments could draw cheques on their Expenditure Clearing Accounts held at the BOJ, as the Central Bank would honour those cheques regardless of whether there were adequate resources in the accounts.
This resulted in large amount of funds leaving the Central Bank to fund Central Government expenditure, financed by "advances" from the Central Bank to Central Government. The law required that such advances be cleared within three months of the end of the fiscal year, from the revenues.
The reality was that these overdrafts were carried forward from year to year, not only contributing to inflation but also creating a situation which impaired the balance sheet of the BOJ.
In 1992 the Government took the decision to control the build-up of advances to Central Government by the BOJ and, as a first step, a decision was taken to establish banking relationships with the commercial banks. However, the Consolidated Fund, the Debt Accounts and some revenue accounts were still maintained at the Central Bank.
Since 1992 there have been no advances from the BOJ to Central Government. From time to time, the BOJ invests in GOJ's instruments on commercial terms similar to those offered to any other institution or retail investor. These instruments, carrying market interest rates, are freely tradable securities and are used by the BOJ in its conduct of monetary policy. The securities are either sold outright by the BOJ or used to back the Bank's reverse repos.
The maintenance of the Consolidated Fund in the BOJ still posed challenges for liquidity management. Consequently in 1998 Consolidated Fund accounts were opened in the commercial banking sector.
In February 2003 when it became apparent that we would not be able to raise funds on the external capital market and there was the need to repay a bond issue of ¢200 million, the Central Bank paid the debt from the NIR. In turn, the BOJ was compensated by the Government with LRS at prevailing market interest rates.
Over the course of the financial year 2003/2004, the GOJ paid to the BOJ $7.55 billion in principal and $6.4 billion in net interest for its holdings of GOJ securities. At the same time, the BOJ's investments in GOJ securities totalled $18.47 billion.
I sincerely hope that this clarifies the financial relationship between the Central Bank and the Central Government.
MEDIUM TERM
Normally, what is presented here are the major macro-economic projections for the medium-term. The comparison of the targets established for fiscal year 03/04 against the actual outturn as at March 31, 2004 is instructive. GDP growth at 2.1% was within the range, the NIR was significantly above the target. The primary surplus, as a percentage of GDP was on target and the deficit was within the range of 5%-6% of GDP. Our only deviation in terms of macro-economic target was in terms of the inflation result.
This year as has been done for the past several years, the outline for the next three years will be presented but first we need to spend some time on what I consider the most significant development which will impact on the medium-term - the signing of a Memorandum of Understanding between the Government of Jamaica and the major trade unions representing public sector workers.
It is useful for us to indicate the path leading to this historic development. Last year in the month of November, I decided to have a series of exchanges with critical partners to indicate the present state of the economy and the prospects for the future. The meeting with the trade union leadership was by far the most productive as their first request was for full information prior to any decision on the way forward.
We responded to their request for information indicating several important aspects about the fiscal, including the increasing percentage taken up by interest payments, and wages and salaries. Furthermore, we demonstrated that wages and salaries, in real terms, had improved compared to inflation, as a percentage of total expenditure and even in US dollar terms.
The presentation also indicated that unless we were able to obtain some understanding, the prospects were for the deficit to grow. Given that this was untenable, the only option which the Government would have at that stage would be for severe cuts in employment.
The sensible option which was expressed by both sides would be to find a way to protect employment and simultaneously curb the rate of growth of wages and salaries. Furthermore, there was an acceptance that there had to be adjustments within the public sector to bring about greater efficiency levels.
We worked throughout the Christmas period and through January leading to the historic signing on Monday, February 16. Subsequently, the MOU has been signed by the JTA and we confidently expect that within the near future the other unions and groupings representing public sector workers will be on board.
Three final comments are in order. The first is that the maturity demonstrated by the leadership of these unions must be publicly recognised. Whilst all the leadership contributed, Senator Dwight Nelson has been the critical factor in guiding the process and he and his colleagues must be saluted.
The second is that whilst we will have hic-cups from time to time, all of us who signed the MOU are committed to ensuring its success. Furthermore, we are convinced that it has laid the basis for a new era in the socio-economic architecture of this country.
The third point to be made is that this historic agreement has given credibility to the Government's fiscal targets not only for fiscal year 2004/05 but also for 2005/06 when we plan to eliminate the deficit.
In terms of the macro-economic targets for 2004/05, we project inflation of 9 per cent, GDP growth of 2.5 per cent, NIR as at March 31, 2005 of (US)$1.3 billion, a primary surplus of 13.7 per cent of GDP and a deficit of between 3 per cent and 4 per cent of GDP.
The achievements of the last fiscal year gave creditability to these targets and should provide creditors with the assurance that our target of eliminating the deficit in the next fiscal year 2005/06 will be met.
